Reference no: EM13315633

Write a review of the following article.

Brown, J. (2010). Dividends and investment strategies. Research Reports: American Institute for Economic Research, 77(16), 1-3.

Incorporating your knowledge of finance and equity valuation, explain the key points that the author is trying to communicate. Your review should be at least 1 page and no more than 2 pages, not counting the title or reference pages.

Article Review: Dividends and Investment Strategies by Jeff Brown

The article compares choosing dividend-paying stocks as an investment strategy to other options, and lists key points to be considered while selecting this strategy. The article stress to point that in an economy of low interest rates, dividends may be thought of a key source of regular income, however, investors should be cautious of risks associated with stocks and should have the potential to hold the stocks for long-term if the market had to collapse driving stock prices down.

Some of the key points in deciding the dividend-paying stocks were that they were the worst hit during the financial crisis, with majority of the dividend-paying companies reducing or eliminating their dividend thus creating an uncertainty whether investing in dividend-paying stocks is the right strategy. Added to this is the probable return of high tax rates which was cut by the Bush administration. Tax on dividends were reduced to 15% from 39%, while long term capital gains taxes were reduced from 20% to 15%. If tax rates have to resume to higher levels, dividends may not be preferred by investors as dividends would be taxed in the very year it is received as opposed to capital gains that will be taxes only when the shares are sold (or never if it passes as an estate). However, over the long term, a majority of the returns (44%) were attributable to dividends given the assumption that if these dividends were reinvested again. The returns were significantly lower if the dividends were not reinvested into the stocks.

The author also introduces the key terms involving dividend-stocks, yields and payout. The yield measures the dividend paid over the 12 months divided by the current stock price, and the payout measures the percentage of corporate profits earned that were paid out as dividends to shareholders. A key point is that high dividend-yield stocks tend to outperform low-dividend yield stocks over the long term. However, investors have to cautious to the fact that a fall in share prices erases most of the returns provided by higher dividends, and thus investors cannot compare yields to those on safe investments such as bank deposits. Also, considering a time range of 1971 to 2010, stocks that increased their dividends or initiated new dividends tends to outperform stocks that maintained or decreased their dividends which outperformed stocks that did not pay any dividends. The key reason is that cutting dividends signal issues in the company that the top management faces. Also, a key point to note is that dividend-paying stocks tend to beat market averages in a bear market, and tends to trail market averages in a recovery.

The author also mentions about the ‘Dogs of the Dow" strategy where investors select the 10 highest yielding stocks from the 30 stocks in the DJIA, and stay invested in them for 12 months. This portfolio is revisited and modified every 12 months. While this strategy has been successful for some time, there are also critics who argue that the market would price the stocks to avoid any bargain that investors would receive by following this strategy.

To summarize, although dividends seem lucrative than bank savings and bonds in a low interest rate economy, the inherent risks in the stocks should be considered before taking a decision to invest. Dividend-stocks are not a good option for goals that require immediate income. However, dividends are a good opportunity for regular income, if the investor has the time to hold on for long-term given a strong reduction in stock prices due to a market meltdown.